Investors eye bright spots in REIT sector

(Reuters) - While investors say they are wary of the broader real estate industry in a rising interest rate environment, some are still bullish on sectors such as self storage and manufactured homes.

Real Estate Investment Trusts (REITs) are typically seen as a defensive investment bet as their large dividend payouts offset slow but predictable growth.

The S&P 500 real estate index .SPLRCR has outperformed in the last six months with a 5.8 percent climb compared with the broader S&P 500's .SPX 0.4 percent advance.

REITs have been boosted recently on earnings strength and a slump in U.S. Treasury 10-year yields. But some investors expect them to lose steam if bonds yields turn higher, assuming that the U.S. Federal Reserve keeps raising interest rates and the economy stays strong. Investors typically prefer bonds to defensive sectors like REITs when interest rates are rising.

The REIT sector however is down 0.2 percent for the year-to-date compared with the S&P’s 4.7 percent gain. It already lagged the S&P 500 for the last two years with a 7 percent rise in 2017 compared with the S&P’s 19.4 percent advance and no change in 2016 compared with the S&P’s 9.5 percent increase.

But some REIT subsectors, which have already outperformed the real estate industry so far in 2018, may continue to climb.

The FTSE Nareit Equity Self Storage index .FTFN12 has risen 18.6 percent in the last six months and 10.6 percent year-to-date making it the biggest gainer in the sector. Self storage companies include Public Storage (PSA.N), CubeSmart (CUBE.N) and Life Storage Inc (LSI.N).

Even with these gains, and an oversupply of capacity, self storage is still attractively valued, said Cedrik LaChance, Director of REIT Research at Green Street Advisors.

“In the last seven to eight years self storage companies have become very adept at marketing online,” said Bob Zenouzi, a chief investment officer specializing in real estate at Macquarie Investment Management. “People can’t afford a home and need to downsize. You have stuff and need to store that stuff.”

REITs that lease land to consumers who buy or rent manufactured residences such as mobile homes also stood out.

The FTSE Nareit Equity Manufactured Homes index .FTFN19E has risen 16.3 percent in the last six months and 8 percent year-to-date. Companies in the sector include Equity Lifestyle Properties (ELS.N) and Sun Communities (SUI.N).

“We always love manufactured homes. It’s ignored by too many investors so it remains attractively priced,” said Green Street’s LaChance who sees low capital spending costs as a key advantage. “In real estate capex is really important and takes away a lot of the economics.”

Macquarie’s Zenouzi says that hefty price tags for traditional houses are making manufactured homes more attractive to cash-strapped consumers.

“Demographics are a tailwind because retirees want to downsize. House prices are up. These are lower cost options.”

Hotel REITs have also done well though some investors are getting wary. They have been helped by a boost in business travel due to U.S. economic strength and recent U.S. corporate tax cuts. And when demand is strong, hotel REITs are better placed to quickly raise rates for short-term customers than REITs in long-lease sectors such as office or healthcare REITS.

The FTSE Nareit Equity Lodging/Resorts index .FTFN24 rising 4.8 percent in the last six months and 6.4 percent year-to-date. But those gains may have run their course.

“The share prices are effectively pricing in this rebound of corporate travel. Its priced in so aggressively we’re starting to see hotels as an expensive sector,” said LaChance.

Even if there are bargains in REITS, John Laforge, head of real estate asset strategy at Wells Fargo Investment Institute, in Florida warned against getting “over your skis” in the broader sector. Instead he favors fast growing sectors like industrials, healthcare or technology.

“We’re late in the economic cycle. It’s very classic for REITs to start underperforming,” said Laforge who recently downgraded the sector to ‘neutral” from a “favorable” rating.